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KKR's Revamped Finance Tactics Lead in Private Equity's Evolving Landscape

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Leo Gonzalez

May 3, 2024 - 11:49 am

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KKR Leads Private Equity Investments in Innovative Finance Strategy

In a groundbreaking move within the private equity sector, KKR & Co., along with its executives, has positioned itself at the forefront of industry investments by having approximately $25 billion dedicated to its funds. This substantial figure transcends what is typically disclosed during KKR’s financial earnings calls and press statements, revealing a more complex financing structure underpinning the firm's investment strategy.

The financial powerhouse has employed a less visible segment of the asset-backed securities market in recent years, generating capital for new fund investments by marketing portions of its existing fund positions. To accomplish this, KKR consolidates these assets into structured products known as collateralized fund obligations (CFOs), which are transacted in private sales — often involving insurance companies, some of which are under KKR's ownership.

Despite the lack of clarity on the exact funds raised through CFOs, this method is a testament to KKR’s adaptive approaches leveraging current trends within private equity. These strategies are designed to enhance potential returns, albeit while increasing risk exposure, and reflect a broader industry shift where fund managers are allocating significantly more of their capital to co-invest with clients.

Crestline Investors’ David Philipp, a partner leading the fund liquidity solutions group, explains that enhanced general partner commitments play a pivotal role, especially in challenging fundraising climates. Such commitments can act as a catalyst, reassuring some investors when large amounts originate directly from the manager.

KKR's Strategy in Private Equity

In a statement, KKR described the usage of CFOs as efficient funding mechanisms that have minimal impact on the firm's overall financial health. Traditionally, money managers and their executives, collectively known as general partners (GPs), contribute around 2% of the capital when promoting a new fund to potential investors. Remarkably, in the past year, this percentage has more than doubled, averaging about 5% and in certain cases soaring to 20%, as reported by Bloomberg.

The commitment from GPs has not only grown in percentage terms but also in dollar figures, driven by an aggressive expansion of private equity fundraising. US-based private equity (PE) firms accumulated $2.7 trillion from 2019 to 2023, as per Preqin’s data, marking a significant rise from the $1.3 trillion raised between 2014 and 2018.

As Michael Rosen, the chief investment officer at Angeles Investment Advisors, highlights, a 2% GP commitment may be modest in scale, but it represents a substantial monetary stake given the volume of capital PE firms are now handling.

By the culmination of last year, KKR's commitments to its funds, which encompassed roughly $20 billion from the firm and an additional $5 billion in private wealth from principals such as co-founder Henry Kravis and co-CEO Scott Nuttall, stood at about $25 billion.

This level of investment contrasts starkly with Blackstone Inc.’s $2.8 billion in fund commitments and holdings reported at the end of December. Blackstone’s senior managing directors likewise had significant commitments, amounting to $2.2 billion in Blackstone funds. However, the total value of their investments remains unseen.

The variations between firms like KKR, Blackstone, and Carlyle Group can be attributed, in part, to their differing management philosophies. While Blackstone and Carlyle prefer to keep minimal assets on their balance sheets, KKR adopts a more direct investment approach in assorted businesses and its private equity funds. Moreover, KKR’s go-public merger with an affiliate introduced a heftier capital base to the combined entity.

At certain firms, partners partially cover their fund commitments through loan facilities provided by the private wealth branches of leading banks, including JPMorgan Chase & Co. Scott Aleali, who heads private equity finance at Citizens Private Bank, notes that this GP financing—typically secured against the partner's fund stakes—carries a floating interest rate that is positioned 300 to 400 basis points above a benchmark rate.

KKR’s utilization of the asset-backed market for financing capital commitments first surfaced in the company’s 2019 annual report amid a spike in private equity fundraising. Although KKR remains reticent about detailing its CFO operations, the annual reports do acknowledge “structured transactions” that involve financing from third parties for vehicles investing in KKR funds.

Fitch’s Greg Fayvilevich points out that CFOs emerged on Wall Street in the early 2000s to allow large institutional investors to liquidate private equity investments. A less typical scenario is witnessing the money manager itself initiating CFOs.

In a particular case from July 2021, KKR executed two CFO deals dubbed Husky and Bobcat. These transactions were structured by allocating parts of the firm’s commitments from roughly 20 KKR funds into two special-purpose entities. Subsequently, these entities issued 10-year senior bonds at an effective interest rate of around 5.7% and a lesser quantum of subordinated debt bearing approximately 7.8% interest, primarily to insurers. About $1 billion was invested in Husky and Bobcat CFOs by three KKR-affiliated insurers through senior debt acquisition.

Senior bondholders have the privilege of prioritization when it comes to repayment through the distributions from KKR fund stakes owned by Husky and Bobcat. Thus, these bonds are accorded with investment-grade credit ratings, garnering them regulatory favor and making them appealing debt securities for insurers, according to Fayvilevich.

The proceeds garnered from the bond offerings are strategically utilized by KKR to meet capital commitments for newer funds being marketed to prospective investors. Furthermore, KKR maintains equity interests in CFOs such as Husky and Bobcat, positioning the firm at the forefront to absorb potential losses. Consequently, KKR is exposed to the majority of the risks and also stands to gain from any profit outcomes on the sold stakes.

As 2022 concluded, KKR’s investment in CFOs spiked to approximately $2 billion, up from $620 million at the end of 2019. The firm also acknowledged a potential burden of up to $116 million for investment losses. While KKR ceased revealing such investment figures in 2023, further CFO transactions are anticipated. In January, KKR amalgamated parts of its fund stakes into a special purpose vehicle labeled 2023 Bear Financing, encompassing more than a dozen funds and partnerships, including notable buyout funds catered to North American and Asian markets.

Aleali summarizes the evolution of GP financing over the last decade, emphasizing not just the increasing size of GP commitments but also the mechanisms afforded to firms’ employees to invest in their funds. The innovative financing strategies adopted by firms like KKR demonstrate an advancing sophistication within the private equity landscape, coupling traditional elements of investment with novel financial engineering to optimize capital structures and enhance overall fund performance.

In addition to embracing new leverage forms to raise potential returns, private equity firms and their general partners are committed more than ever to co-investing substantial capital alongside their clients. Such an approach reflects a dynamic and strategic shift in private equity management, ensuring both scalability in investment endeavors and alignment of interests between managers and investors.

KKR's involvement with CFOs and the corresponding use of asset-backed securities to finance fund commitments underscore an inventive progression in how private equity firms access and use capital. As private equity evolves to accommodate varying market conditions and investor expectations, firms must continuously explore and adopt advanced financing techniques to maintain competitive positioning and long-term growth.

Show Us Your Money, Investors Tell the Titans of Private Equity

In summation, KKR’s trajectory in private equity investment ventures displays a highly sophisticated and proactive approach to fund management. By utilizing mechanisms like CFOs and taking larger stakes in its funds, the firm embraces both the potential upsides and inherent risks with confidence. Amidst an ever-changing financial landscape, KKR’s strategies are not only reflective of its corporate ethos but are also a hallmark of its leadership in the broader private equity realm.

For a deeper insight into KKR's financial profile and the emerging trends within the private equity industry, including further analysis of their CFO issuance, you can follow developments through Bloomberg's specialized reporting, available at Bloomberg.